Information management and transfer pricing

Abstract

The paper considers information flow in a profit-centre organization. There is internal trade between two divisions. Headquarters records realized sales revenues and decides whether or not to pass this information on to the selling division. The selling division announces a cost-based transfer-price schedule that includes a mark-up on variable cost. From headquarters' perspective, the key issue is to influence the seller's manipulation of the mark-up. Knowledge about revenue enables the seller to squeeze intermediate profits out of the buyer and, moreover, to mitigate trade distortions. However, this comes at a cost. If the buying division receives a lower share of joint profit there arises a distortion of incentives for revenue-increasing efforts. Thus, the appropriate management of revenue information serves as a non-trivial tool to close gaps between the objectives of the whole firm and those of the divisions.